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Is it ever too late to start saving?

Tex-free lump sums and employee contributions. These are the reasons to opt-in to your workplace pension when you're over 55.

By John Lawson

There are a lot of older people who simply think they are too old to save; that they have missed the boat. Research shows that over 55s who are automatically enrolled into their workplace pension are three times more likely to opt out than 20-40 year olds 1.

But the odd thing about this is that over 55s have the greatest advantage when saving into a pension, because they can get their hands on the money right away. Not only that, but you get the benefit of a tax-free lump sum and an employer contribution, as the following example illustrates:

Bill is 57 and has just started a new job. His employer tells him that he’ll be automatically enrolled into a workplace pension. Bill will have to put in 5% of his £25,000 annual salary and his employer will pay in 3%.

If Bill doesn’t opt out, the cost to him of staying in is £1,250 a year. However, Bill also qualifies for tax relief at 20% of the gross payment, or £250. That means the net cost of contributions is only £1,000.

On top of that, £750 will be paid into the pension by Bill’s employer, meaning that the total amount paid in is £2,000.

If Bill wanted to, he could take the whole £2,000 straight back out. One-quarter (£500) would be tax-free and the other £1,500 would be taxable at Bill’s highest marginal tax rate of 20%. This would mean that £300 tax would be deducted if Bill took all the money straight back out.

Overall, Bill would receive £1,700 back out the pension at a net cost of only £1,000.

With such clear-cut and immediate financial benefits, it is therefore surprising that older people are opting out.

There is no need to take your money out straight away, and you will get the same benefit if you leave the money in your pension. In fact, because a pension is a tax-efficient shelter, it is actually best leaving your savings there until you need them. Any tax benefits are subject to change, and depend on individual circumstances.

Another disadvantage of taking all your money out immediately, is that the moment you take a taxable amount from your pension (as Bill did), new annual contributions into your pension are limited to £4,000, rather than the normal £40,000 a year. This is called the ‘money purchase annual allowance’ and is there to stop people taking too much money out of their pension every year, paying it back in as a new contribution and getting more tax relief.

Saving through the workplace

Employers are now obliged to automatically enrol you into their own workplace pension scheme and for most older workers, it makes good financial sense to stay in.

A band of earnings between £6,136 and £50,000 (from April 2019) is used to calculate minimum payments, but many employers disregard these limits and simply calculate contributions on your whole earnings.

You have to pay in 5% of your earnings and your employer will pay in 3%. In total, payments will be a minimum of 8% of your gross earnings within the band of earnings set out above. However, as noted, your employer may decide to base contributions on all of your earnings.

You also get tax relief, so the net cost coming out of your pay packet will usually be less than the full amount. For example, if 5% of your gross pay equals £200 a month, the net cost to you will usually be just £1,600. The net cost of a £200 gross contribution could be as low as £110 if you pay tax at the additional rate.

Some employers are also more generous. Not only do they calculate contributions based on full earnings, they also match what you pay in – for example, if you pay in 5% of your gross pay, your employer will also pay in 5%.

Check with your employer how they calculate your pension payments.

As mentioned at the start, most people that are enrolled into a pension should stay in. There are a couple of main exceptions:

Unless your employer pays the whole pension contribution on your behalf, people with high-interest debts like store cards or payday loans, may want to pay off debt before saving in a pension. But if you are over 55, this is less of a concern, as you can take money straight out of your pension, which might even help you get your debts under control.

People whose pension is more than the lifetime allowance (£1.055m in 2019/20) or who expect it to exceed that level by retirement. Many people in this situation deliberately opt out to avoid high rates of tax on any excess savings over the lifetime allowance. Whether this makes sense for you will depend upon whether your employer compensates you for opting out. Anyone with this level of pension savings should speak to a financial adviser to determine the most appropriate course of action.